The subprime mortgage crisis has left banks spooked, afraid to lend money to each other, let alone to consumers. Now the European Central Bank has made an unprecedented offer: it's offering banks unlimited funds at below-market rates in the hope that it will keep the cash flowing.
It is part of a coordinated plan, unveiled last week, in which the ECB, the Bank of England, the U.S. Federal Reserve, the Bank of Canada and the Swiss National Bank will try to ease an impending new year freeze in wholesale money markets.
Each of the banks said they will pump additional reserves into their respective systems to help free up credit.
The moves represent skirmishes in the battle to keep the world from sinking into a major recession.
On Monday, the Fed made $20 billion available in one-month loans, although the participating banks were not named.
The amount due to be auctioned by the Bank of England on Tuesday has been raised from 2.85 billion pounds ($5.7 billion) to 11.4 billion pounds ($23 billion).
The process will be repeated Jan. 15 before the Bank looks at whether further measures are necessary.
Since the outbreak of the credit crisis in August, the ECB has already provided ample short- and long-term liquidity to the market, but financial institutions prefer to lend to good corporate clients rather than to each other, keeping term rates around 5 percent, said Niels Christensen, analyst at Nordea in Copenhagen.
Financial institutions also need more funds around the year-end to square their balance sheets, while securing liquidity is becoming increasingly difficult as banks are reluctant to lend to each other in a market overshadowed by the threat of subprime debt.
Last week, the ECB drained 21 billion euros ($30.47 billion) from the market.
Nathalie Fillet, strategist at BNP Paribas, said in a research note that with the ECB guaranteeing the year-end funding, rates for maturities from overnight to one-month should trade lower. "However, the decline will be capped by the idea that the ECB will remain pro-active and ready to adjust liquidity one way or another," she added.
The benchmark allotment, which is the ECB's estimate of funds that banks need to conduct their routine operations, is 182 billion euros ($262.5 billion).
"This benchmark amount takes into account all liquidity needs of the banking system until Jan. 3, 2008, leaving out the liquidity effect from the main refinancing operation to be settled on Dec. 28, 2007," the ECB said.
"The allotment amount in this two-week operation will not be bound by the benchmark amount but will be decided, as announced, in full consistency with the aim of keeping interest rates close to the minimum bid rate," the ECB said in a separate statement.